Trupanion Inc (TRUP) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Trupanion Fourth Quarter and Full Year 2017 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Laura Bainbridge. Thank you. You may begin.

Good afternoon, and welcome to the Trupanion Fourth Quarter and Full Year 2017 Financial Results Conference Call.

Before we begin, I would like to remind everyone that during today's call, we'll make certain forward-looking statements regarding the future operations, opportunities and financial performance of Trupanion within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release, which can be found on the Investor Relations website as well as the company's most recent reports on Form 10-K and 8-K filed with the Securities and Exchange Commission.

Today's presentation contains references to non-GAAP financial measures that management uses to evaluate the company's performance, including, without limitation, fixed expenses, variable expenses, adjusted operating income, acquisition costs, adjusted EBITDA and free cash flow. When we use the term adjusted operating income or margin, it is intended to refer to our non-GAAP operating income or margin before new pet acquisition. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis, which excludes stock-based compensation expense and depreciation expense. These non-GAAP measures are in addition to and not a substitute for measures of financial performance prepared in accordance with the U.S. GAAP. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today's press release or on Trupanion's Investor Relations website under the Quarterly Earnings tab.

Lastly, I'd like to remind everyone that today's call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site.

With that, I'd like to turn the call over to Darryl, Trupanion's Founder and CEO.

Thanks, Laura, and good afternoon, everyone. Today, I'll review our 2017 highlights. I'll keep my remarks brief as we intend to provide more detail in my forthcoming shareholder letter and during our 2018 shareholder meeting, which will be held in Seattle on June 7.

In short, our 2017 performance was in line with our expectations. We have a good understanding of the levers that have driven our business historically, and the team did a great job modulating our growth within our operating constraints. We also continue to see positive results from our test initiatives, though it's still early days in determining how repeatable these tests are at scale.

Revenues for the year grew 29% year-over-year, which is at the top end of our 20% to 30% target range. Our other business segment contributed 5% to the year-over-year revenue growth, primarily due to the addition of a new partner. Revenue growth also benefited from a 9% ARPU increase in our subscription business, the results of our efforts to accurately price each of our subcategories. These efforts contributed to a strong improvement in the lifetime value of a pet, which increased 15% year-over-year to $727 from $631 in 2016.

Continued expansion in the lifetime value of a pet increases our allowable PAC spend, which enables us to be more aggressive in testing a pet acquisition, while still achieving a strong rate of return. In addition to having a higher LVP, the continued expansion in our adjusted operating margin also increases the funds available for us to invest in pet acquisition. We achieved this primarily through scale in our fixed expenses. In 2017, scale in our fixed expenses drove adjusted operating margin to 10%. In dollars, we generated adjusted operating income of $23 million, a 58% increase from the $15 million in the prior year.

In 2017, we elected to spend $18 million of the $23 million on pet acquisition, an increase of $4 million over the prior year. The bulk of this was spent on well-understood strategies in our core channels or those that deliver highly efficient and predictable subscription pet enrollments. In addition to our core channels, this spend included our same-store sales initiatives as well as direct-to-consumer testing, which was primarily TV. Based on early encouraging results, we intend to continue with these and other tests in 2018.

In 2018, based on our forecasted increase in the adjusted operating income, we will have significantly more available to spend on pet acquisition. In general, we intend to invest in one of 3 ways. First, we will continue to spend on our known channels, as this is the core engine of our growth. Second, we are planning to increase spend on test that showed positive early results, but we do not yet know whether those results are repeatable or scalable. And thirdly, we're testing completely new strategies that may or may not be successful and our spend will need to adjust dynamically.

Our core channels will continue to comprise the majority of our 2018 spend; however, we expect to allocate a greater percentage to our less-proven channels comprising the second and third buckets where we have less visibility. While I spend the bulk of my commentary today highlighting our financial progress, 2017 was also a strong year operationally. We worked well as a team. We strengthened our culture and advanced our key strategic initiatives. You'll recall, these 5 key strategic initiatives are around increasing same-store sales, increasing conversion rate, scaling our adjusted operating margin, having more friends referrals and existing members adding more pets, all with a goal of offsetting churn or our version of nirvana, and the fifth, automating payments of veterinary invoices.

In some areas, we made more progress than others. These are hard multiyear initiatives, but we continue to work diligently to deepen the modes around our business. We will elaborate more on these efforts at our upcoming Annual Shareholder Meeting, and I encourage you to attend in person to get the benefits of this discussion. We designed this day to be far different from a typical shareholder meeting. For our shareholders, this all-day event is your opportunity to get in-depth access. You can expect to meet our team, experience our culture and spend a significant portion of the day with a large panel of leaders answering the questions that you care about most.

In summary, 2017 was a solid year financially and operationally. We continue to advance our mission to help the pets we all love receive the best veterinary care. At the core of our efforts is building the trust of veterinarians and their staff and giving them the confidence to initiate conversations to pet owners of Trupanion. We're encouraged by our progress, but we still have a long way to go.

And with that, I'll turn the call over to Trish.

Thanks, Darryl, and good afternoon, everyone. Today, I will highlight our financial achievements from 2017, discuss our fourth quarter results and provide our outlook for the first quarter and full year of 2018.

2017 revenue of $242.7 million increased 29% compared to 2016. These strong results were due primarily to the roll on of a group of pets in our other business segment, which contributed 4% of our year-over-year growth and ARPU increases that were above our historical average of 5% to 6%. The impact of 2017 ARPU being above 6% contributed 3% to our year-over-year revenue growth. Additionally, we saw positive results from some of our test initiatives, which helped enroll incremental pets.

2017 adjusted operating income available to invest in growth was $23 million or 10% of total revenue, up from $14.8 million or 8% of total revenue in the prior year. Our net loss for the year was $1.5 million. In 2017, we also achieved positive free cash flow of $6.5 million. Our operating cash flow for the year was $9.7 million.

I'll now turn to our results for the fourth quarter. Revenue of $66.5 million was up 30% year-over-year. Over the same time period, total enrolled pets increased 23% to approximately 423,000. Subscription revenue was $59 million, up 24% year-over-year and benefited from higher-than-average ARPU increases. Total enrolled subscription pets increased 15% year-over-year to approximately 372,000 pets as of December 31.

Our average monthly retention was 98.63%, up from 98.6% in the prior year period. Our other business revenue, which generally is comprised of our revenue that has a B2B component, totaled $7.6 million for the quarter, an increase of 93% year-over-year. Year-over-year growth in our other business segment reflects an increase in the number of pets enrolled. Total enrolled pets in this segment was approximately 52,000 at year-end.

As we mentioned last quarter, the significant growth in our other business throughout 2017 was the result of a new relationship that began to enroll pets at the beginning of the year. In 2018, we expect pets from another relationship to begin rolling off, which we project will result in this segment's growth rate in the range of 20% for 2018.

Subscription gross margin was 19% in the quarter, within our annual target of 18% to 21%. Total gross margin was 18%. For the quarter, fixed expenses represented 8% of total revenue, down from 10% in the prior year period, reflecting increased scale in our technology and general and administrative departments.

Turning to our pet acquisition costs. In the fourth quarter, we spent $5.6 million on pet acquisition for a PAC of $184. This resulted in an LVP-to-PAC ratio of 4:1. In the prior year, we spent $3.8 million or a PAC of $133, resulting in an LVP-to-PAC ratio of 4.7:1. Our 15% improvement in LVP to $727 during the quarter as well as our scale and adjusted operating margin allowed us to have this incremental spend in pet acquisition cost during the quarter, while still maintaining a strong internal rate of return. Having incremental spend available to us during the quarter enabled us to be more aggressive in core channels and also test new channels such as TV in order to drive incremental pet growth. Adjusted operating income totaled $6.3 million in the fourth quarter, a 53% increase from the prior year period.

As a percentage of revenue, adjusted operating margin expanded approximately 140 basis points year-over-year to 10%. We had a net loss of $0.8 million for the quarter or a $0.03 loss per basic and diluted share compared to a net loss of $1.7 million or $0.06 per basic and diluted share in the prior year period.

Adjusted EBITDA was $0.7 million, up from $0.3 million in the prior year period. And free cash flow was $2.1 million, including operating cash flow of $3 million for the quarter. This compares to free cash flow of $3 million in 2016, which includes operating cash flow of $3.4 million.

At December 31, we had $63.3 million in cash, cash equivalents and short-term investments and $9.5 million of long-term debt.

I'll now turn to our outlook for the full year and first quarter of 2018. Revenue for the full year 2018 is expected to be in the range of $292 million to $298 million, representing 22% year-over-year growth at the midpoint. This revenue outlook is primarily reflective of our expectations for our core spend through our known channels that deliver strong predictable returns. It's also worth noting that these projections reflect growth around 20% in our other business revenue along with ARPU growth more in line with our historical average of 5% to 6%. As we have discussed, we expect that a group of pets in our other business segment will roll off during the course of 2018. The impact to revenue growth will be more pronounced in the second half of the year and is reflected in our full year guidance.

At our forecasted revenue levels, we would expect to have positive adjusted EBITDA and cash flow. However, it is our goal to deploy as much of our adjusted operating income as we are able in order to drive incremental revenue growth while also supporting our desired rates of return on acquisition spend. We will monitor the performance of this spend throughout the year and update you on our progress each quarter. For the first quarter of 2018, revenue is expected to be in the range of $68 million to $69 million, representing 25% year-over-year growth at the midpoint. At these revenue levels, we would expect adjusted EBITDA to be around breakeven.

Also, please keep in mind that our revenue projections are subject to conversion rate fluctuations between the U.S. and Canadian currencies. For our first quarter and full year guidance, we used an 80% conversion rate in our projections, which was the approximate rate at the end of December.

Thank you for your time today. I will now turn the call back over to Darryl.

Thanks, Trish. At Trupanion, we're still in very early innings of building our company and the category. We seek relationships with long-term-minded shareholders who share our excitement and vision for the future. In May, we'll be hosting a small event following the Berkshire Hathaway Annual Shareholder Meeting in Omaha. This is a great venue to connect with like-minded investors, and we hope to see many of you there. For more details, please visit our IR website.

And with that, we'll open the call up for questions.

(Operator Instructions) Our first question is from Mark Argento from Lake Street Capital Markets.

Just wanted to drill down a little bit on the pet acquisition cost. I know, you really had a growth strategy in place to deal more aggressive, bringing down that LVP-to-PAC ratio which you have over the last couple of quarters. You didn't mention PV is one channels that you guys are focusing a little bit more on. Could you talk about how that's going and some other potential opportunities for you in terms of expanding that bucket?

Thanks, Mark. We've been testing around with TV starting a little over a year ago. We've been testing in markets where we have higher number or higher percentage of active hospitals. We have it at a point now that our pet acquisition spend is greater or is less than a lifetime value. So we're bringing on in a profitable way, but not yet hitting our internal rates of return targets that we would like to hit. So I would say they're kind of in that second bucket where we need to continue to do testing. We need to work on conversion rates. We need to see how they rollout. So we learn the churn in retention rate. So we're going to continue to do more of that in 2018. And we'll be probably testing in some additional cities in different areas. But we're not at the point yet that we can really put our foot on the accelerator and hit it really hard because we're not sure of the lifetime value of these pets, and we need to get them a little bit more efficient.

In terms of other channels, maybe online in particular, I know you talked a little bit about social. Any developments there? Those become more efficient channels for you or still fairly nascent.

They're pretty nascent. I mean, they are a small percentage of our total enrollments. What we've been doing last year in '17 was mainly testing more in the back half of Q3 and Q4 was around same-store sales initiatives and direct-to-consumer. In both of those areas, we saw an increase as we started to scale up our new enrollments. So we're pleased with those spends. Online, we haven't seen quite the same capacity. And the majority of what we're really seeing is slowly building up brand awareness and increasing conversion rate. And that was why we had better growth rates in Q3 and Q4.

Our next question is from Jon Block from Stifel.

Maybe just 2 or 3 quick ones for me. So Darryl, the gross add growth seemed to pick up. I believe it was around the low double digits year-over-year, again, for the gross adds and acceleration from prior quarters. Obviously, you're spending, you mentioned LVP to PAC, but how do that play out with, call it, same-store sales growth versus new hospitals? And then maybe that ties into are you seeing greater progress with your same-store sales initiative? And then I've got a couple of follow-ups.

Well, thanks for noticing the pickup in the growth rate. We've been working hard at it. And the breakdown was really some higher conversion rates that we saw at the end of the year. We attribute that to both our same-store sales initiative and some of the direct-to-consumer. But that is where the growth is. It's not been by adding more stores. So more same-store sales than higher conversion rates.

Okay. Got it. And maybe 2 quick ones. Trish, just for you, you gave obviously the '18 guide. But if we think about adjusted operating income of around $30 million this year, is that in the right ballpark when we think about in absolute adjusted OI.

Yes, things definitely need to play out. But yes, that's right. In that range is how we're entering the year. And then the guide, like I said, is based on our core channels and more normal historical ARPU increases. What it is above that is how effective we are at deploying that additional capital.

Got it. And last one for me, just sort of big picture. And Darryl, maybe you will touch on this in your shareholder letter, but maybe we can get some comments from you ahead of that. So the number of pets for operational scale, do you still consider that to be around 650,000 to 750,000 pets? And is there an updated time frame for that scale?

I still believe that 650,000 to 750,000 pets is the appropriate number for us to be hitting our operating scale, which will give us 15% adjusted operating margin target. As I mentioned in the last year's shareholder letter, my ability to predict when that's going to happen, it will really start to play out over the next year as we deploy more and more capital. If we can do it where we get strong rates of return, we have enough capital to kind of get there in a shorter time frame. But if we're not able to deploy that capital effectively, and we stay disciplined, it may take a little bit longer than I originally thought. So we'll have to play it out and see where it comes in.

Our next question is from Paul Penney from Northland Securities.

This is Greg on for Paul. First, could you provide any color on updated TPA hiring stats in existing and emerging NSA markets?

The update on the number of territory partners we have in the field and the number of active hospitals is something that I hold off for my shareholder letter, which will be coming out in -- around April. I can tell you that we have seen progress through the years on the frequency of visits or the density, number of territory partners in the field. That combining with our inside sales or same-store sales initiatives, where we are attaching account managers to hospitals. The combination of more frequent touch point is part of our formula for increasing same-store sales, and we expect more of that to happen over the next several years.

Okay, great. And then just one follow-up. What percentage of new subscribed pets roughly are coming from pet owner referrals versus vet referrals? And then what percent comes from B2C marketing channels?

So what you're talking about is existing clients either referring pets or adding their own, which is how we kind of -- I point a term nirvana where that existing pets telling their friends or adding offset our churn. That number is historically where our churn has been about 1.5%. And the offset on referred add of pet has been about 0.6%. So we're about halfway between the churn and having that organically grow on itself. As far as the amount is on the B2C, it's still a pretty small percentage. We're about 80% of all of our leads are coming from either pet owners or veterinarians referring us. And then we have about 10%, a little over 10%, where people are getting it from either a breeder or shelter where they're getting the pad and the balance, which is less than 10% coming from direct-to-consumer.

Our next question is from David Westenberg from CL King.

So consolidated practices are picking up speed. We're getting 10%-plus in terms of number of practices and about 20%-plus in terms of revenue. Can you talk about the different strategies for touching a corporate practice versus touching an individual practice, both on the sales force level and both on the corporate level?

Yes, David, you bring up a good point, in that there is about 28,000 veterinary hospitals and a little over 2,000 are corporately owned, but that number is seemingly increasing. You've got private equity coming into the market. You got some roll-ups happening. A lot of roll-ups are in the kind of 20- to 80-hospital range, with Mars being the principal, I think a little over 2,000 hospitals. You also have buying groups that are trying to help the independent hospitals compete with the corporate teams so that they can buy diagnostics and lab equipments and pharmacy and other things. So in general, I think we've done a very good job aligning ourselves with the corporate owners as well as the independently owned. The corporate owners have been paying in the most recent years a higher multiple on what they're buying a hospital for. And I think that's driving the behavior of wanting to see better same-store sales to get a better replacement on their return on their investment. And the fact that our clients visit 2 -- twice as often as a client without insurance. And our clients are spending more money is a great method for these corporate or independent hospitals to improve same-store sales. I think we've got good alignment. I was recently at the VMX tradeshow in Orlando, and I think the sentiment towards the category and towards Trupanion continues to show positive reinforcement that more insured pets means good growth for owners of independent or corporately owned.

Our next question is from Thomas Champion with Cowen & Company.

Can you update us on the process of bringing down the percentage of unprofitable pets? I'm just curious if you hit the 10% target? And whether or not we should consider this kind of a retention headwind into 2018, having gone through the process?

So your question, several years ago, I brought up the fact that about 20% of our subcategory is a pet. We're either mispriced or we were spending more to acquire than we were getting back as a lifetime value. We really put a big focus on it. If you want more details, you can read my shareholder letters the last couple of years that kind of highlights it. Last year, that we took it from about 20% down to 17%. And as you mentioned, we had a target of getting to about 10% by the end of '18. As you can see by the increase of a lifetime value of a pet that went from $631 to $727, about a 15% increase year-over-year, that was driven by that improvement. And I'm happy to say that we slightly surpassed our 10% target. So we're pleased with the progress we've made.

Our next question is from Dylan Haber from RBC Capital Markets.

Just in terms of your inside sales team, have you built that out? What sort of impacts have you seen it have on same-store sales? And then with regards to your LVP, do you think there's any natural ceiling for that figure or long term or it can just continue to grow?

So the inside sales team or account managers who are having more frequent touch points, we said at the last shareholder meeting that it had a 43% increase. So we were pleased with it. Now we wanted to try to add velocity. We're going to be working on doing that. And I expect that the shareholder meeting this year that the leadership team and the people closer to it will be answering Q&A on that, providing ideas on what the progress has been and how we see that going forward. Your second question was related to LVP. I expect the LVP we'll be able to continue to grow at 5% to 6% year-after-year following the ARPU. I don't expect the retention rates are going to get dramatically better than what we currently are at. But I do not see a ceiling on this. We have no sign that pet owners are price-sensitive when it comes to the parts of their family. So if you look out 10 or 20 years, we think our ARPU will go up so will LVP.

Your next question is from Michael Graham with Canaccord

This is Austin on for Mike. Few questions please. You mentioned you were able to get the amount of mispriced pets down below your 10% target, but still seeing pretty nice expansion in the retention rate. Wondering what explains the improvement in retention? And how we can think about that next year, if it can remain as high, go higher, if you're anticipating it to contract perhaps? And then the second question is on competition. It seems to us at least that there's been a little bit of consolidation. I'm wondering if the increase in pet acquisition cost can be explained at all by inflation due to essentially more competitor spending.

Let me talk to the competition question, first. We really don't see any change or impact on the number of competitors in the field or as the consumer see it the number of brands. The competitors have very little impact on what we're spending. We're spending most of our money generating leads from the veterinary channel and spending on direct-to-consumer trying to increase conversion rate. So it's not really as much on lead generation what a lot people reflect on if you think of online and some other areas. So I don't think competition is really driven -- or have much of an impact on what we're spending or how we're spending our money. The first part of your question regarding retention rates. Our 10 to 15 historical average has been 98.5%. The last couple of years we been averaging about 98.6%. I'm still not at a point that I would recommend that you move your models up to 98.6%. I think 98.5% is the best average, and it's what I use for planning. When we think about trying to get to nirvana or having our referral amount of pet offset our churn, its retention is key, but I think the biggest opportunity for us is increasing the referrals.

Yes, I would just add a little bit to that. One of the things that we benefited from this year, particularly, in the back half of the year, we put that our systems and processes in place, particularly, around credit card updating. And we've seen a noticeable impact to our retention in that regard, which has helped to offset some of the other headwinds with some price adjustments that we put through. Forward-looking, particularly, if we are able to deploy an incremental capital and add additional pets retention, we may see some variability there since we do see lower retention in the first year of enrollment than we do thereafter. So there's a little bit of push and pull to keep in mind as we go into 2018.

Thank you. There are no further questions in the queue. This concludes the question-and-answer session as well as the teleconference. Thank you for your participation. You may disconnect your lines at this time.